Hollande-Merkel agree on financial transaction tax

Supporters of a financial transaction tax have a strong ally in the new French president, Francois Hollande, who wants to recycle the revenue raised from the so-called Tobin tax into growth-enhancing investment projects. On this, if little else, he may have the backing of German Chancellor Angela Merkel, but not of British Prime Minister David Cameron, who believes the City of London would be damaged by the proposed levy.

Opponents of the FTT say it would raise the cost of doing business and would hinder rather than stimulate growth. It would cost more for firms to do currency deals and so make exports dearer, and it would push up interest rates, leading to lower investment. A lower level of transactions would mean that the yield from an FTT would be lower than expected. What's more, it would be subject to considerable tax avoidance.

Brussels believes it would be nigh-on impossible to avoid paying an FTT but its attempts to quantify the tax's impact do appear to suggest there would be a hit to growth, albeit a modest one. Initial work by the European commission showed that on the assumption of 1.5 per cent annual growth and a 0.1 per cent FTT on shares and 0.01 per cent on derivatives, GDP would be 0.53 per cent lower by 2050. More specifically, GDP would be 81.4 per cent above today's level without an FTT and 80.9 per cent with one.

The commission has now refined its model to take into account the fact that many firms - particularly small and medium sized companies - don't rely on the financial markets to fund investment, but raise funds from retained earnings or banks instead. Once this is taken into account, the growth hit is reduced to 0.2 per cent in total by 2050.

What, though, if the tax raised by an FTT - €57bn a year according to some estimates - were to be pumped back into the economy? This is a course of action, dubbed balanced-budget growth, in which policymakers leave overall tax and spending levels unchanged but seek to move resources from low growth to high growth sectors of the economy. The International Monetary Fund champions this approach, as does the Social Market Foundation.

According to the commission, using the resources raised by an FTT for investment, either at a national or European level, would boost growth rather than detract from it. Again, the numbers are quite small: overall GDP would be between 0.2 per cent-0.4 per cent higher by 2050. Lobbyists for the FTT, however, say this underestimates the growth potential of the tax, as the likely reduction in high-frequency trading would lead to greater financial stability and thus a more favourable climate for sustained growth.

Cameron thinks financial stability can be achieved in other ways, through the bank levy and by beefing up the watchdog powers of the Bank of England. He sees an FTT as a Trojan horse, designed to curb the City. The mood, though, is different in France and Germany, under pressure to boost the eurozone and, even more importantly, to find ways of financing it.